Two Areas Flat Rate Doesn't Work
Julius Ballanco, P.E.
Do you ever feel like you've been challenged? In the past few months, it has appeared that way with regard to flat rate pricing.
While avoiding the debate about flat rate pricing, I am aware of two areas where flat rate pricing does not work. Furthermore, it can get you into trouble. The two areas of concern are litigation and taxes.
First, litigation. I know that most of you hate the word attorney. However, attorneys are a part of our lives. One thing I learned early on in this business is that you cannot prevent someone from suing you. In other words, anyone can sue you for anything. The key is to win the lawsuit.
The majority of lawsuits involving plumbing contractors revolve around the cost of an installation. Whether there is a dispute over quality, argument over some form of damages, or simply a failure to pay, the financial terms of an original installation will be discussed in great detail.
I have been involved in a number of these lawsuits, and the one thing that has come through loud and clear is that flat rate pricing doesn't work when it comes to justifying cost. Anytime there is a flat rate price given, the first thing the opposing counsel asks is, "Can you break down the costs? What is the material cost, what is the labor cost, what is the overhead, what is the profit?"
The larger the project, the more detailed the price breakdown must be. I have observed contractors state that they use flat rate pricing, and there is no breakdown in pricing. The attorneys go nuts on the contractor for this kind of statement. You see, attorneys like to use the famous word "precedent." This means that somewhere in the annals of the plumbing profession, some individual declared that the way we price plumbing installations is by labor, material, profit and overhead.
DocumentationIf you don't believe me, just check what every organization has published regarding estimating and pricing. This would include PHCC-NA, MCAA and ASPE. Each of these organizations uses the standard labor, material, profit and overhead method of pricing.
Hence, the plumbing contractor is forced to break down his pricing and justify every segment of that breakdown. Thus, if you flat rate price, you better have the justification prepared for every number you use. Then, be prepared to justify those numbers when an attorney confronts you.
By the way, plumbing contractors tend to squiggle in their seat when asked to justify their labor price. There really is no reason for that. The best response I ever heard was by a friend of mine who was being deposed. The attorney asked, "Why do you charge such high rates for your labor?" He responded, "Because those are my rates." The attorney just kept going on with his questions, never asking another question about labor prices.
You see, attorneys are trying to rattle you. If you don't let them, they normally move on. After all, how do some attorneys justify a rate of $500 an hour while others get $175 an hour? They will respond that there is a difference in quality. The same can go for you - higher quality!
One last thing on labor rates. Some attorneys and public officials want you to charge the going rate. To do this, you need to discuss labor rates with your competitors. If you discuss labor rates with your competitors, it is called price fixing, which happens to be a violation of the Federal Trade Laws.
So, if ever asked in a legal proceeding, always respond, "I don't know the going rate, since any discussion of labor prices with my competitors would be a violation of the Federal Trade Laws. I decide the labor rates based on what I perceive to be the value of the service."
Pay The StateThe second area where flat rate pricing doesn't work? Sales taxes.
I work in a number of states. None of these states charges sales tax on labor. I would guess that the majority of the country does not have a sales tax on labor.
When you invoice a flat rate, without any breakdown of labor, there is sales tax on the total amount of the invoice. The problem arises from the fact that flat rate pricing charges for an installation. There is material included in the installation. Hence, you are selling a product. You are not charging for labor. Technically, the labor is free because you charge a single rate for the product.
Assume a fixture cost $100. Your labor to install the fixture was $200. Your profit and overhead was $60. (I just made up these numbers.) If you add the numbers together, the total price for a flat rate would be $360. If the sales tax was 5 percent, you would then tack on $18 for sales tax.
It you took these same amounts and provided a break down on the invoice, the sales tax would be on the $100 material cost. The tax would only be $5, which is a savings of $13.
You may be saying, "Who cares, my customer is paying the taxes, not me?" While this is true, think of what this adds up to at the end of the year.
If your company took in $1 million total in flat rate pricing for the year, with a 5 percent sales tax, you would write a check to the state for $50,000. However, if only $200,000 of that total was for material costs in the flat rate pricing, you would only have to write a check for $10,000 to the state. Of course, the state would love for you to flat rate price, since they collect a windfall of additional taxes.
A contractor may run into problems when the state chooses to audit his books. Many contractors still are only sending the state their share of the money for the material costs. Rather than sending the $50,000 from our example, they send the state $10,000 based on the way they calculated the material costs.
Tax specialists don't look at it this way. During an audit, the state looks at the invoices. If the invoices don't show a separate breakdown for labor, it expects to receive sales tax on the full amount of the invoice. You could be stuck paying the additional $40,000 of sales tax that you never collected from your customers. Oops!
Tax TipsOne smart contractor I know solved this problem. He would tell his customers the flat rate price for the installation. Then when he invoiced, the invoice had the complete break down of the costs, material, labor, profit and overhead. (By the way, profit and overhead do not have any sales tax associated with them, either.) The bottom-line price was the flat rate price. The sales tax was added to the material amount giving the final cost of the installation.
The beauty of this is that the auditors can't complain. Technically, when the invoice is issued, the contractor is not flat rate pricing. The quote for the job is a flat rate, but the invoice is the old standard labor and material.
My recommendation is that you check with a tax specialist or the state tax people. Most accountants don't get into this level of minutiae, so check with the experts. Remember, if there is a problem, the accountant isn't going to pay your back taxes, you will.
This is just my response to the challenge of where flat rate pricing won't work. I'll leave the subject alone from now on.